Being green has been a top priority for the commercial real estate industry for the last couple of decades, so it may be easy to forget that the S in ESG doesn’t stand for sustainability. It stands for social. While the Environmental, Social, and Governance framework for assessing a company’s sustainability performance is growing fast in commercial real estate, it’s clear that the S in ESG, like a homely cousin, is getting a lot less attention than the Environmental pillar.
And it makes sense. The environmental aspect of sustainability is top of mind with all of the talk of climate change. Plus, it is a way for properties to save money in the long run while making themselves more attractive to investors with sustainability mandates. Most building owners have long ago adopted any number of cost-saving, environmentally friendly measures ranging from energy-efficient lighting to green roofs to solar panel installations.
But that doesn’t mean that the social aspect should be overlooked. Social’s current position in the shadow of Environmental may be attributed to a common misconception, and that is that it doesn’t have a notable impact on the bottom line. But more evidence is coming out that it actually does. Social components of a building can include things like labor practices, health and wellbeing initiatives, diversity and inclusion, and community engagement. There are a host of reasons why property owners should ensure that their Social initiatives are on par with their Environmental efforts.
Tenants are increasingly demanding an environment that supports their quality of life, be it at an office building or a multifamily property. “Everybody is much more aware of the fact that their built environment is affecting their health, their family’s health, their co-workers’ health, and their employees’ health,” said Joanna Frank, president & CEO of Active Design Advisors, the operator of healthy building certification platform Fitwel. “A connection has been made that built environments do have a direct impact on your life expectancy.” If tenants don’t get what they want in the form of certain Social features at a property, they can easily go elsewhere, leaving behind vacant space.
Real estate investors are also pushing for more activity in the Social category, and part of the increasingly loud cry is related to financing. Given the high-interest rates in the U.S., many real estate investors are turning to financial institutions and other lending entities in Europe to raise money, and Europe is leading the way globally in mandating that companies report quantitative data on ESG activities. If a property in the U.S. doesn’t meet Europe’s stringent ESG requirements, then securing financing from large European institutions like pension and sovereign wealth funds is practically impossible.
In terms of accommodating tenant and investor demands for meeting the criteria of ESG’s Social aspect, the key is not just incorporating certain social-related policies but providing quality, certified data that can substantiate the improvements. Currently, in the U.S., ESG disclosure is voluntary. Also, there is no official framework for reporting, although the Securities and Exchange Commission is in the process of fine-tuning a proposal for a new rule, The Enhancement and Standardization of Climate-Related Disclosures for Investors. The regulation would require SEC-registered entities, including those in the real estate sector, to disclose information regarding climate-related risks and other ESG components that could have a material impact on a business.
But for now, companies seeking to improve ESG performance rely on third-party associations like the Green Business Bureau, the Global Reporting Initiative, GRESB, Well, and Fitwel. Fitwel has created a new certified metric approach identifying a subset of strategies from the Fitwel standard that has the greatest impact on real estate value and, therefore, the greatest risk to real estate. Fitwel isolated the subset of strategies to guide property owners on how they can use their buildings to maintain the quality of life for occupants and the community. The subset of strategies includes such community-focused steps as flood risk mitigation, fire risk mitigation, and stormwater management. For example, property owners can increase the tree canopy on their site to help reduce air temperature or incorporate highly porous surfaces that will help decrease the risk of flooding. Again, the S in ESG has a strong connection to the bottom line. Per FEMA research, every dollar invested in flood mitigation at a property translates to a $7 return on investment.
Social-oriented improvements also pay into tenant satisfaction. Factors like indoor air quality matter, as do accessibility to outdoor space and proximity to transit. There are also less glamourous issues that are of great import to the Social segment of ESG, such as integrated pest management and cleaning protocols. “It isn’t perhaps what the industry thinks it is. It isn’t the shiny amenities, but it is actually the kind of core way that you are managing and maintaining buildings that are having a greater impact upon the satisfaction of the tenants and investors,” Frank said.
Overall, there is no one-size-fits-all method for incorporating the Social segment of ESG into a business. In the commercial real estate sector, Hines is among the growing number of companies that are giving Social equal play. Hines has defined six categories under the Social segment (compared to five categories under the Environmental and Governance pillars), including Attainable Housing, Diverse Suppliers, Education, Level Playing Field, Health & Wellness, and Community Building. In 2022, the global real estate company established a Strategic Sourcing Community of Practice to identify diverse suppliers with an eye toward increasing its diverse supplier spending to an internal goal of 7.5 percent by the end of 2023. Among the many other steps Hines is taking to expand its activities in the Social segment is the company’s new focus on the workplace destigmatization of mental health through employee resource groups and communication campaigns.
As part of the Social element of its ESG program, multifamily owner and developer AvalonBay Communities began rolling out its Second Space mixed-use concept in 2021, offering furnished offices for monthly rental to apartment residents and community members to accommodate the demand for turnkey remote-work space. The commercial real estate community is, in many ways, better positioned to act on the social element because it does have access to or control of much of the built environment, where any number of Social-focused programs can be offered to employees and community members alike.
There’s every reason why the S in ESG should be given the same attention as the E in the acronym. Just because ESG’s social pillar involves non-financial factors doesn’t mean it has no financial relevance. Social is becoming increasingly important to tenants and investors alike, and addressing their demands is essential to achieving the tenant satisfaction necessary to maintain occupancies and vital to investors’ ability to meet strict international standards involving European financing and potential European buyers. It also looks like before long; the SEC will be requiring many American corporations to report on their ESG improvements. Buildings, maybe more than any other business, can improve the lives of the people in and around them. Hopefully, before long, doing so will be seen as a profitable as well as socially beneficial endeavor.
